Flash Note

Carmignac Patrimoine: built for a narrow path

Carmignac Patrimoine’s positioning reflects its global management philosophy through a diversified and balanced allocation. Our portfolio construction aims to optimize our view of the cycle on the Fixed Income and Equity components as well as seizing alpha generation opportunities.

TOP-DOWN CALLS - THE REFLATION TRADE

Extension of the global cyclical recovery characterised by a progressive synchronisation and a pick-up in inflation beyond ‘base’ effects.

Equities

• Being more selective on the U.S. market after a strong performance.

• Benefiting from positive internal dynamics that support the energy sector beyond the reflation trade.

• Maintaining our Japanese financial investments and increasing our exposure to European markets.

Fixed Income

• Maintaining a low modified duration* strategy with an active management via futures contracts on U.S. and German government bonds.

Financial markets are currently experiencing a synchronized growth, favourable for risky assets. Between the extension of the cyclical recovery and political headwinds, the equity and fixed income components of Carmignac Patrimoine are primarily built around macroeconomic themes and bottom-up opportunities. These uncorrelated strategies are key to managing risks within the Fund and emanate from team synergies between the Cross Asset, the Equity and the Fixed Income teams.

The reflation trade

This on-going cyclical recovery, reinforced a year ago by the Chinese stimulus when the U.S. cycle was bottoming, has supported financial markets. Stronger global economic growth, continued accommodative monetary policies in Europe and Japan and anticipation of further fiscal stimulus should remain supportive for equity markets, particularly for some cyclical segments – such as commodities-linked stocks and financials. However, investors should keep in mind that selectivity remains key.

As the U.S. markets have led the rebound, we may observe a rotation from U.S. equities to Europe and emerging markets. Accordingly, we have started to reduce our U.S. equity exposure focusing on components with the higher growth potential.

Regarding the energy sector, as we witness continued discipline from the members of the OPEC as well as healthy global demand trend (+1.3% year-on-year), we remain constructive on oil-price developments. Moreover, stagnant non-OPEC supply could potentially lead to a supply shortfall next summer, dragging inventories into line by autumn. However, the oil market could remain volatile due to uncertainties around the increase in U.S. shale production. Consequently, we remain selective and focus our energy exposure on high quality and low debt companies operating primarily in the Permian Basin; America’s largest shale field leading the U.S. oil recovery.

On the other hand, as the financial sector lagged the energy trade at the turn in 2016, several opportunities persist within the banking universe, especially in Europe and Japan where valuations remain attractive. Besides benefiting from the acceleration of growth and inflation, the sector will also be buoyed by the potential relaxation of banking regulations.

Our exposure to financials accounts for 7.9% of Carmignac Patrimoine (as of 31/03/2017), and is mainly focused on Japanese banks. Operating in the world’s lowest interest rate environment, those banks are set to reap the benefits of the incipient global rise in interest rates. Yet it is worth noting that their shares trade on average at a 40% discount to their net assets. Bank of America, one of the banks best-equipped to capitalise on higher inflation and interest rates in the U.S., also deserved to be included in the portfolio.

In Europe, political uncertainties have constrained market performance, despite the improving macro and micro-economic data. As such, we have invested in the European banking sector. However, with the business model of European banks appearing less attractive, we have chosen to invest through a banking index in order to remain flexible. To benefit from a broader positive momentum, we have started to slightly reinforce our exposure, particularly through the consumer discretionary sector.

The pickup in growth is also accompanied by an uptick in inflation, which is not only attributable to a base effect. Energy and food price increases tend to spread to the lagging components of the consumer price index. The prolongation of this upturn cycle confirms our cautious positioning on our fixed income portfolio which is translated by our low-duration* strategy implemented last summer. Nevertheless, we may tactically adjust our short positions on U.S. and German rates to weather policy execution risk brought about by President D. Trump, and to navigate the upcoming European political elections.

Opportunities in emerging markets

In emerging markets, firmer growth and normalising inflation should bolster the recovery in company profits and therefore benefit our emerging markets equity exposure, which is divided between macro-economic opportunities and long-term stock picking convictions.

Following the results of state elections in India, Prime Minister Narendra Modi will continue to implement pro-business policies that should deliver solid economic growth and buoy equity markets. Therefore, we have slightly increased our Indian equity exposure.

In Mexico, Cemex is a macro play, as it should be one of the first beneficiaries of increasing infrastructure spending around the world. Finally, MercadoLibre, a dominant Latin American e-commerce player, should benefit from a strong under-penetration of online sales in the region.

On the fixed income component, we are maintaining our exposure to emerging markets sovereign and corporate debt. We continue to favour commodity-linked debt such as Brazil, Mexico, Pemex. We have been witnessing a divergence in emerging markets inflation where low-yield countries (usually commodity importers like Central Europe, China, Korea, etc.) have experienced an inflation increase while high yield countries (usually commodity exporters like Russia, Brazil, Colombia, etc.) have undergone deleveraging and are seeing an inflation drop.

Bottom-up convictions

The return of a more normalised economic cycle should make stock selection the primary driver of performance. This is in stark contrast with the situation of the past several years, when heavy intervention from central banks caused liquidity expectations to change constantly, making equity market trends dependent on investment in index funds.

Disruptive companies in the IT sector are a long-term high-conviction play in our global Funds. While growth-oriented technology stocks trade at premium to the market Price to Forward Earnings multiple, with a backdrop of relatively low structural global growth, and with business models based on disrupting legacy models, we believe these valuations are justified. The growth technology sector has performed strongly since the start of 2017. Four sectors in our current positioning will shape tomorrow's world: Communications, Media, Internet and IT. D. Trump’s presidency might benefit these sectors through proposed reductions in corporate tax rates, favourable terms for the repatriation of overseas cash, as well as through reduced regulation. Combined with the sector convergence trend, this should create an environment ripe for mega M&A deals in the U.S. later in 2017.

On the Fixed Income side, if European core inflation rebounds faster, and more sustainably, than expected by the consensus, market anxiety about a possible faster conclusion to ECB asset purchases will require a more cautious allocation to corporate credit. Moreover, credit metrics are deteriorating and the risk return profile is getting less and less attractive globally. This leads us to take some profits. But opportunities still exist. Since the summer of 2012, we have benefited from an outsized exposure to European banks across the capital structure. The drivers to this theme remain in place: European banks are one of the few sectors in all of global credit with a multiple-year visibility of continued de-leveraging. Regulatory changes have driven seven years of deleveraging and de-risking that is likely to continue through 2019. In particular, we think subordinated bank bonds are particularly cheap in absolute terms, but also relative to industrial high yield. Finally, we still like Collateralised Loan Obligations. This remains a broken asset class, where regulatory constraints and crisis scars allow us to benefit from very attractive spread levels.

Risk Management

If this economic upturn is a global phenomenon, from which the “Trump factor” is only one component, it should not outshine the risks that markets could be facing in the coming months. In Europe, upcoming elections mean that political uncertainties remain. In the U.S., we are witnessing growing uncertainties around the ability of President Trump’s administration to implement reforms. As with political risks in 2016, we rely primarily on adequate portfolio construction, monitored through stress tests, in order to provide robustness in case of adverse events. In the coming weeks, we’ll actively monitor our positions. Tools to be used will be determined based on market conditions. Optional instruments, delta-1 instruments (futures) and currencies could be considered, depending on costs and risk of time decay.

Currently, in the context of the upcoming elections in France, the likelihood of wobbly equity markets, of dovish Central banks, and of some frailty in the Euro, is rising. Therefore, should our fundamental analysis remain unchanged, ahead of this period of uncertainty we may decide to tactically adjust our market positioning. Early April, we have reduced our equity exposure, particularly by hedging our European exposure through the implementation of several options strategies with technical targets depending on the different scenarios. We may also use our currency exposure as a tactical tool to manage the risks of the portfolio. However, political risks must not obscure the economic phenomenon characterised by a strong and global economic recovery. The cycle will remain predominant in our management decisions.

*Duration: A bond’s duration is the period beyond which interest rate variations will no longer affect its return. The duration is like a discounted average lifetime of all flows (interest and capital).

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